Ben Aris in Murmansk -

Russia's oligarchs became fabulously wealthy almost overnight in the 1990s, but having secured their fortunes a few are starting to plough billions back into businesses they hope will pay them dividends for decades to come. Andrey Melnichenko's EuroChem has invested over US$ 700 million in an apatite mine inside Russia's Arctic Circle to extend its useful working life by at least 40 years. This is helping to build up a group that has already emerged as a top ten global fertiliser maker turning over $5bn a year. 

Murmansk is just inside the Arctic Circle and at the end of April there is still snow on the ground, despite the fact spring is starting to bloom in Moscow more than a two-hour flight to the south. The deep fiord and nearby Gulf Stream makes this one of Russia's two warm-water ports (now three if you count Crimea, which was annexed from Ukraine in March last year) and a logistics hub for the country's copious raw material exports. It is one of a dozen Russian cities to be awarded “hero city” status, as it was used by the Allies in WWII to supply the Red Army with “lend-lease” equipment and was more-or-less flattened by the Nazis as a result.

Today it is a bustling, if somewhat rundown, port city studded with a handful of new shopping centres and renovated hotels. Several ships stand in the docks being loaded with coal that belongs to SUEK, a EuroChem sister company, or already filled with apatite concentrate and iron ore from the Kovdorskiy mine situated in a town of the same name three hours’ drive into the barren hinterland.

Kovdorskiy is home to massive deposits of phosphorous ore, also referred to as apatite (P₂O₂), a high quality phosphate rock, which is found in a mineral formation that is also rich in iron ore, and baddeleyite (ZrO2), which is mainly used in ceramics, while its cubic crystalline form is better known to the man in the street as zirconia crystals, used to make kitschy sparkling decorations. All three minerals are mined and processed at the Kovdorskiy plants and exported all over the world, although China remains the most important customer for iron ore concentrate and Japan for baddeleyite concentrate where it has several industrial applications. “Iron ore prices have plummeted in the last year from over $120 to about $60 per tonne now, but the baddeleyite can still get a very good price of up to over $5,000 per tonne,” says Clark Bailey, who hails from the US state of Texas and is head of EuroChem's mining operations.

The Kola Peninsula is impossibly rich in minerals, home to almost the entire periodic table (known in Russia as the Mendeleev table after Professor Dmitri Ivanovich Mendeleev, the Russian scientist that invented it). Seven of these minerals can be found nowhere else on earth, the staff at the Kovdorskiy mine boast, but it is the apatite that attracted EuroChem’s interest.

Like many of his oligarch peers, Melnichenko made his money in the rough and tumble of the 1990s. Still in his 40s, Melnichenko set up MDM bank, which specialised in providing “real” banking services to the oligarch-controlled banks that grew rich from speculating against hyperinflation. After the collapse of the banking sector’s top tier in the 1998 crisis, MDM emerged as one of Russia's leading commercial banks. However, in 2004 he began selling control of his banking business to his partner Sergei Popov, putting the money into industrial assets including coal miner Siberian Coal Energy Company (SUEK) and utility company Siberian Generating Company (SGC), earning a second fortune in the process. Melnichenko lost 80% of his wealth in the 2008 crisis, with his net worth falling to $1bn according to Forbes magazine, but by the start of 2015 it had recovered to $9.7bn.

A big player in Russia's mining sector, in the West Melnichenko is probably better known for his $300mn luxurious yacht, called simply “A”, which was designed by Philippe Starck (of bathroom fittings fame) and is second only in size and ostentatiousness to that of fellow oligarch Roman Abramovich.

Advantages

EuroChem has been building one of the world’s largest vertically-integrated fertiliser companies since 2001. The company is aiming to be among only four companies to produce nitrogen, phosphates and potash following the launch of its potash operations in 2017.  Over the last few years EuroChem has picked up several more companies and mineral assets. To secure resources and bolster its raw materials portfolio, the company took over the Kovdorskiy mine in 2002, and is developing two potash mines in Russia. One is near Volgograd (better known as Stalingrad) and is called EuroChem VolgaKaliy, while the other, EuroChem Usolskiy, is in the Perm region. EuroChem has also launched phosphate ore production in Kazakhstan in 2013. Additionally, EuroChem has entered into a joint venture with Chinese fertiliser producer Migao Corporation as a way of developing the Asian markets.  It also has three nitrogen plants (two in Russia and one in Belgium) , three phosphate plants (two in Russia one in Lithuania), and a global sales and distribution network with a core focus on the European market but including sales offices spanning from Mexico to China. Altogether the group produced close to 12mn tonnes of fertilizers in 2014, a number set to rise by at least 8mn tonnes once its potash plans are realised. “We currently meet about three-quarters of our phosphate rock needs [from our Kovdorskiy mine], which is why we bought Taraz [in Kazakhstan],” says Bailey. “While today we buy potash from third parties, we are planning to be fully sufficient once we have our own potash production.”

As a company, EuroChem has several strong competitive advantages. The first is its massive natural resources portfolio, which includes apatite and phosphate rock, potash, and hydrocarbons. It also has large gas reserves of 493bn cubic metres (m³) and produces 1.1bn m³ of gas a year, which currently meets a quarter of the company's needs. Gas is a major source of hydrogen in the production of ammonia which is the basic chemical building block for most fertilisers.

Transport is another of the company's advantages. In addition to the proximity of the Kovdorskiy mine to the port of Murmansk, the company also has a terminal on the Black Sea a few hundred kilometres from the Volgograd potash mine currently being developed, as well as a terminal in Sillamae (Gulf of Finland) in Estonia, and dedicated jetty access in the port of Antwerp in Belgium. Providing further cost benefits, the company can count on some 6,400 rail cars and its own Panamax size ships to assure flows of raw material and final product.

History of Kovdorskiy

The wealth of minerals and the Kola peninsula's geographical isolation meant that Stalin built a large Gulag complex in the region. The Kovdorskiy deposit was discovered in 1933, but because of WWII the original mine with a 6mn tonnes per year (t/y) capacity of iron ore only became operational in 1962. It wasn’t until the 1970s that the mine started producing apatite concentrate and later baddeleyite concentrate potash.

Since EuroChem took over in 2002, the mine has been vastly expanded, and there are still plans for future growth The company began to work the mineral rich tailings in 2007 that were previously ignored – as the mine was initially configured for the extraction of its high-quality/Fe content iron ore. Then began an ambitious expansion project starting in 2011 that has seen the production of raw ore increase from the original 6mn t/y to 23mn t/y today (including 5mn t/y of apatite and 18mn t/y of iron ore). The eventual goal is to raise production to a maximum of 40mn t/y.

The mine continues to get deeper and wider, but an entirely new processing plant has been constructed over the last 18 months that came on stream earlier this year. Unlike Murmansk's blackened Soviet-era infrastructure, EuroChem's brand new blue and yellow modern buildings stand out from the grey surroundings.

The mine itself is a huge open pit. Giant BelAZ and Caterpillar trucks ferry ore from the bottom of the pit to the processing plants, where the rock is crushed and the minerals and iron ore are separated out of the slurry using magnets and floatation processes.

Currently the pit is 414 metres deep and the company expects to sink it another 460 metres. This means several factory buildings on the pit's lip will have to be moved back from the edge. But the main apatite-staffelite ore deposit extends in a pipe to more than 2,000m below the surface. EuroChem will eventually have to go deeper underground to get at the rest of the ore body. All in all, the mine has at least another 40 years of life in it.

Business philosophy

EuroChem is already turning over a very healthy $5bn a year, investing its profits back into the company. It has already invested $2.5bn into developing its two potash mines and continues to funnel some $400m-500m a year into this new segment.

It is also spending a similar amount on upgrades and developments across its nitrogen and phosphates operations, such as at the Kovdorskiy mine. When EuroChem took over the Kovdorskiy mine in 2002 its future was a lot less certain. “The previous owners were more concerned with generating cash rather than investing in the future. What we are building here is a long-term sustainable business that has decades of life left,” says Clarke Bailey. Cumulatively, once the potash mines are completed, Olivier Harvey, head of investor relations, estimates the company will have spent more than $10bn on developing its business, with over half going to its potash projects and the rest across its other operations to increase efficiency and environmental safeguards as well as on social initiatives.

And that is what is so unusual for a Russian company of this type and size. In the last few years, most of Russia's leading mineral extraction firms have been paying out handsome dividends, as their owners want to make safe their wealth with overseas investments. State companies have also been ordered to pay out 25% of profits as dividends to supplement the budget. But for the most part, Melnichenko has gone the other way, continuously and increasingly investing back into the development of the business. “This has been a relatively recent development,” says Bailey, who has been working in Russia for a bit less than three years, but has run mines all over the world. “The strategy is not so much about profits as the strategic development of the business in the context of the fertiliser global market.”

The business has also been relatively unaffected by Russia's clash with the West over Ukraine's future. Fertilisers are not subject to sanctions and continue to attract interest from the outside world. Even the financial sanctions imposed on Russia by the EU and US have had relatively little impact: the company has a low net debt to EBITDA ratio of 1.57x, so can finance the majority of its investment needs out of retained earnings, but it could still borrow if it needs to. “We recently raised $750mn project financing as a syndicated loan with six foreign banks participating,” says Harvey. “Funding [on the international capital markets] is still available to some select [Russian] companies with a good track record and we have worked with all these banks for years, so they know us well. The cost of borrowing has not even gone up that much.”

And the huge devaluation of the ruble since the end of last year has actually been a boon. “We have always tried to match our debt with our revenues. While approximately 60% of the Group’s costs are in rubles, over three-quarters of income is denominated in dollars and euros, so it is easy to have a natural hedge to currency fluctuations,” says Olivier. “The same is true with capital expenditure, across the Group’s operations, while we sometimes need to import certain equipment; we always try to source as much as possible domestically to encourage local industries. Specifically for the potash projects in Russia, the capex breakdown is about 60-40 dollars-rubles.”

The Group’s potash ambitions are justified. It is a profitable business, as unlike most fertilisers that have to be made in a chemical process the pink and white potash salts can be simply dug out of the ground and shipped to customers. Yet the price of potash has been volatile recently; the biggest producer of potash in the former Soviet Union was the joint venture between the Belarus Potash Company and Russia's Uralkali, which broke up in 2012. “The two companies have gone after market share at the cost of the price and that has affected everyone,” says Bailey.

The price for a tonne of potash fell steeply from over $400 per tonne while the cartel was operating, to about $315 as of April, but has started to recover more recently. Bailey says that he expects the price of potash to creep up again in the coming years as the pressure on agriculture driven by the relentless growth of the global population means demand for the mineral will remain strong. But none of the other major potash producers are planning to expand dramatically in coming years, whereas both of EuroChem's potash projects will come online in 2017. “If we are lucky, then we could find ourselves in the sweet spot in the market and be there by ourselves for several years,” says Bailey.